Flash Loan: What is it? Flash Loans are lightning-fast borrowing transactions that do not require collateral and are widely used by professional traders in the crypto market. So, what exactly is a Flash Loan, and what are its advantages, disadvantages? Let’s find out in the article below.
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What is a Flash Loan?
The Emergence of Flash Loan
Flash Loans emerged in 2020 and were developed by the rapidly growing DeFi protocol, AAVE. However, there is information suggesting that Flash Loans actually originated in 2018 by Marble Protocol.
Marble Protocol had a concept similar to Flash Loan, known as Atomic Loan, but in reality, the visions of these two operations are quite similar, yet their mechanisms differ.
Overview of Flash Loan
Flash Loan, as the name suggests, refers to a feature of a product that allows users to borrow money without needing collateral, but they must repay the borrowed amount within the same transaction. This means that the borrowing and repayment period for users must fit within the time frame to complete a block or transaction – borrowing and repayment occur within the same block.
Step 1: Users submit a request to AAVE’s Flash Loan along with a Smart Contract containing loan information, typically the loan amount and interest rate.
Step 2: AAVE validates the transaction information and seeks a lending source for the user.
Step 3: If AAVE finds a lending source, the transaction is initiated.
Step 4: Within the timeframe of a block, users seek profit and repay the loan along with interest as specified in the borrowing conditions at step 1.
Step 5: If users fail to repay the loan, AAVE’s Smart Contract automatically cancels the entire transaction and returns the assets to the lender.
Flash Loans may seem easy to implement, but not every project can develop this product, so there are very few lending & borrowing platforms in the crypto market that provide this service. The most famous Flash Loan protocol is AAVE. In addition to AAVE, some protocols also support Flash Loans, such as Uniswap, Compound, and dYdX.
Some of the advantages and disadvantages of Flash Loans are as follows:
Advantages:
- No collateral required: This eliminates the borrower’s worry of being liquidated and increases market liquidity.
- Versatility: Flash Loans can be utilized in various services such as arbitrage, yield farming, etc. Additionally, they can be combined with different sectors in DeFi like trading, lending & borrowing, yield farming, etc.
- Speed: Borrowers can earn immediate profits, and lenders can earn interest within a short period.
Disadvantages:
- Smart Contract risk: Several Flash Loan protocols have been attacked and hacked, resulting in the loss of significant funds, such as the Harvest Finance attack which lost $24M, among others.
- Flash Loans can involve large sums of money, potentially causing fluctuations in the already thin liquidity of the DeFi market.
Conclusion:
Flash Loans still hold great potential to be explored. However, due to numerous protocol attacks, trust in Flash Loans has diminished. Hopefully, this short article helps everyone understand what Flash Loans are.
